Must-read: James Kwak: “Profits in Finance”

Must-Read: It used to be that we collectively paid Wall Street 1% per year of asset value–which was then some 3 years’ worth of GDP–to manage our investment and payments systems. Now we pay it more like 2% per year of asset value, which is now some 4 years’ worth of GDP. My guess is that, at a behavioral finance level, people “see” commissions but do not see either fees or price pressure effects.

Plus there is the cowboy-finance-creates-unmanageable-systemic-risk factor, plus the corporate-investment-banks-have-no-real-risk-managers factor. We are paying a very heavy price indeed for having disrupted our peculiarly regulated and oligopoly-ridden post-Great Depression New Deal financial system:

James Kwak: Profits in Finance: “Expense ratios on actively managed mutual funds have remained stubbornly high…

…Even though more people switch into index funds every year, their overall market share is still low—about $2 trillion out of a total of $18 trillion in U.S. mutual funds and ETFs. Actively managed stock mutual funds still have a weighted-average expense ratio of 86 basis points. Why do people pay 86 basis points for a product that is likely to trail the market, when they could pay 5 basis points for one that will track the market (with a $10,000 minimum investment)? It’s probably because they think the more expensive fund is better. This is a natural thing to believe. In most sectors of the economy, price does correlate with quality, albeit imperfectly…. And this is one area where I think marketing does have a major impact, both in the form of ordinary advertising and in the form of the propaganda you get with your 401(k) plan…. The persistence of high fees is partly due to the difficulty of convincing people that markets are nearly efficient and that most benchmark-beating returns are some product of (a) taking on more risk than the benchmark, (b) survivor bias, and (c) dumb luck.

April 24, 2016


Brad DeLong
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